Bottom-up vs. Top-down: Don’t put all your eggs in one basket

This is the 3rd post in this series. Here are posts 1 and 2.

In post 1 of this series, I explained what I think are the key differences between top-down and bottom-up organizations and why it’s helpful to think in those terms, rather than other common organization characterizations like government vs. private sector.

At the end of post 1, I listed three reasons why I think bottom-up systems work better than top-down. In Post 1, I elaborated on the first reason. In this post, I elaborate on the second: No single point of failure.

This has been conventional wisdom for a long-time and you may know it better as the phrase, Don’t put all your eggs in one basket.

Why? Because you might drop the basket. This sage advice helps reduce the risk of breaking all the eggs should you drop that basket.

We use this advice when investing. No matter how much homework we do on a company, there are no sure bets. Best not to bet everything on one company.

We consider the advice when planning careers. We train for one career path, but we know it could be automated or outsourced, so it’s best to have backups.

Sports teams try not to bank too much on a single player. Great players are good to have, but they can get injured.

Engineers try to avoid single points of failure when designing systems. Bridges are designed with redundant supports, so they won’t fall if a single support fails. Systems without single points of failure save lives.

Bottom-up systems do not have single points of failure. Baskets can be dropped in such systems. Eggs will be broken, but there are plenty of other baskets to go around.

Why is this good? Because failure happens and it happens more often than success. We live in a trial-and-error universe.

Capitalism is a good example of a bottom-up system. When one business fails, there are others to take its place. It doesn’t take down the whole system. We survived Enron’s collapse, for example. It was not ‘too big to fail’.

Local government is also a good example of a bottom-up system. Local governments can and do fail. Detroit is failing, but it’s not bringing down the whole system. There are thousands more cities, counties and townships. 

School districts don’t yet have a single point of failure. Failing school districts do not bring down the whole system.

Though, school districts have moved toward becoming more top-down over the past few decades as a small group of folks in DC use taxpayer dollars to encourage school districts to deliver on what the folks in DC think is a good education.

This has moved accountability away from parents toward a central point of failure, the ‘common core’ curriculum.

Of course, ‘too big to fail’ is code for ‘single point of failure.’ If it is true that some organization has become ‘too big to fail’ (though I don’t think that was the case in the financial crisis), we should spend more time thinking about how we let a single point of failure crawl into our lives, much the same way the common core curriculum is doing now.

Bottom-up systems are not painless. Failure can be painful. But, bottom-up systems deal with pain and failure better than top-down systems.

Attempting to avoid pain and failure is one reason people advocate for top-down systems. Unfortunately, they soon learn that was a fairy tale.

Fragile society

Bad stuff happens. It’s how you respond and adapt to that bad stuff that matters.

Nassim Taleb coined the term Anti-Fragile in his latest book, Anti-Fragile: Things That Gain From Disorder. It’s a concept worth remembering.

I recognized anti-fragility around the time of Enron. While people were wringing their hands about how something like Enron could happen, I pointed out that corruption, deceit and failure happen all the time in every form of society.

The results are not pretty. But, we were lucky in capitalism that it was contained to a small segment of the economy and didn’t have much impact on overall society. In fact, the economy was resilient enough that it was hardly a blip.

Not only that, but we learned from it.

People learned the important anti-fragile lesson of not putting all your eggs in one basket, as many Enron employees had done by investing all of their 401k’s in Enron stock.

We also learned to be even more skeptical of things that seem too good to be true.

Those are good lessons in any form of society.

Contrast that with the Soviet Union. When it went down, the whole ship sunk.

As we make government more central in our lives, we should recognize that we also make society more fragile, less anti-fragile.

Small businesses are dead capital

Often, when I’m reading a Forbes article and I think to myself, “This is a darned fine article,” I look at the byline to find it is another good article by Daniel Fisher.

That happened recently while reading, How the Government is Helping Hedge Funds Make Billions off IPOs.  This paragraph caused me to glance at the byline:

Hedge fund managers can thank Congress and the SEC for the opportunity [to buy early stakes in companies before they go public]. Some call it “regulatory arbitrage”: well-meaning but inherently flawed laws such as Sarbanes-Oxley that were designed to protect small investors from the next Enron have imposed such heavy costs on public companies that many private ones are delaying their initial public offerings. Venture capitalists, employees and early investors who want to sell out have little choice but to sell their shares to lightly regulated funds, which can buy stock in the next IPO at a steep discount to what retail investors ultimately will pay.

Innovation has a lot of headwinds these days. Most of it caused by (to borrow Fisher’s words) ‘well-meaning but inherently flawed’ ideas.

But I find the well-meaning and inherently flawed ideas around investing in small businesses especially annoying.

In this country you can easily sign up for an online brokerage account and buy and sell slivers of ownership in thousands of publicly traded companies on the various stock exchanges for as little as $4 per trade, with some assurance that the presence of the Securities and Exchange Commission has lowered your chances of being defrauded.

You can just as easily make personal loans to people who need cash now using Prosper.com.

You can donate money to loan to small businesses and create jobs (and make money). Well, at least you get a bracelet with that one.  Or you can lend money to entrepreneurs all over the world. You can also donate to individuals who need help funding the creative projects like a large tortoise that looks like a trading post.

But, if you want to invest with entrepreneurs here at home, it’s not so easy. You need to know somebody who wants to start a business. Or know someone who knows someone. Or you need to know a venture capitalist. Start-up investing is an opaque network of angel investors and venture capitalists.

This, folks will tell you, is for our own protection because there will be too many con men out to get you to invest in their bogus company.

But, I’d rather make it easier for everyone to invest in start-ups and let the market develop solutions to help people from being defrauded. The SEC currently makes trading equity in unregistered companies very difficult. This basically makes small businesses dead capital.

Prosper.com and Kiva.org use simple approaches to limit your risk.  First, you lend in small amounts to individual borrowers — for example, $25 — and you can diversify across many borrowers. So, if you lend to one deadbeat who doesn’t repay you, you’re not out your life savings.

Second, these sites act as an SEC and rating agency of sorts by qualifying borrowers and setting appropriate interest rates based on credit risk. Kiva.org works with organizations that administer the loans with the entrepreneurs with full disclosure on that organization’s track record.

We could use the Prosper/Kiva/Kickstarter models bring start-up and small business capital alive. A similar service could act as registration agent of sorts and market maker to connect investors and business owners and allow users to invest as little as $5 directly with entrepreneurs.

Why not? I’d rather invest directly in an entrepreneur with a chance, even if it is ever so slight, of getting a return on that investment than donate it with the assurance that I won’t.